FEDERATED STATES OF MICRONESIA
SUPREME COURT TRIAL DIVISION
Cite case as Mid-Pacific Construction Co v Semes, 7 FSM Intrm. 522 (Pon. 1996)

MID-PACIFIC CONSTRUCTION CO., INC.,on Assignment for Benefit of Creditors,
and AMBROS T. SENDA,
Plaintiffs,

vs.

HERMAN SEMES and HATLER GALLEN,
Defendants.

__________________________________________

CIVIL ACTION NO. 1992-041

ORDER AND MEMORANDUM OF DECISION

Martin Yinug
Associate Justice

Decided: July 22, 1996

APPEARANCES:

For the Plaintiffs:
Daniel J. Berman, Esq.
Rush, Moore, Craven, Sutton, Morry & Beh
P.O. Box 1491
Kolonia, Pohnpei FM 96941

For the Plaintiff (Ambros Senda):
R. Barrie Michelsen, Esq.
Law Offices of R. Barrie Michelsen
P.O. Box 1450
Kolonia, Pohnpei FM 96941

For the Defendants (Herman Semes):
Charles Greenfield, Esq.
Micronesian Legal Services Corporation
P.O. Box 129
Kolonia, Pohnpei FM 96941

(Hatler Gallen)
Joses Gallen, Esq.
P.O. Box 255
Kolonia, Pohnpei FM 96941

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HEADNOTES

Business Organizations - Corporations - Liability
Any incorporator or director is liable for violations of the regulations governing incorporation unless he can prove an affirmative defense. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 526 (Pon. 1996).

Torts - Fraud
Because the elements of fraud are 1) misrepresentations, 2) made to induce action by the plaintiff, 3) with reliance by the plaintiff upon the misrepresentations, 4) to their detriment, a plaintiff must put on evidence that the misrepresentations were done to induce action by him, and that he relied on them to his detriment. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 526 (Pon. 1996).

Civil Procedure - Summary Judgment
A plaintiff seeking an interlocutory adjudication of all issues of a cause of action must show that there is no issue of material fact and that the affirmative defenses raised are insufficient as a matter of law. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 526-27 (Pon. 1996).

Business Organizations - Corporations - Liability
The de facto corporation defense is insufficient as a matter of law when a company has received its corporate charter. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 527 (Pon. 1996).

Civil Procedure - Joinder and Severance
Rule 21 motions to sever are often more properly brought as motions for separate trials under Rule 42(b). Severance of claims under Rule 21 converts them into independent actions, and is limited to cases in which the claims are separable enough to make appropriate a separate final judgment with its usual consequences. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 527-28 (Pon. 1996).

Civil Procedure - Joinder and Severance
Separate trials should not be ordered unless such a disposition is clearly necessary. Thus it will not serve judicial convenience or economy to order separate trials when both plaintiffs must prove the same liability and where trial together would yield an equitable result. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 528 (Pon. 1996).

Attorney, Trial Counselor and Client - Fees
Where attorney's fees are to be paid out of funds collected and deposited with the court, motions for fee awards will be denied without prejudice when no funds have yet been collected. Mid-Pacific Constr. Co. v. Semes, 7 FSM Intrm. 522, 528 (Pon. 1996).

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COURT'S OPINION

MARTIN YINUG, Associate Justice:

I. Introduction

Several motions are pending in this case. By this Order, the Court grants partial summary adjudication on the motion and amended motion for summary judgment filed by plaintiff Mid-Pac Construction Co., Inc., on assignment for Benefit of Creditors, ("Mid-Pac Creditors"). The motion of plaintiff Ambros Senda to sever his trial is denied. The motions for payment of attorney fees are denied without prejudice. This memorandum explains the Court's decisions.

II. Motion and Amended Motion for Summary Judgment

For convenience, the Court considers the motion and the amended motion for summary judgment filed by the Mid-Pac Creditors as a single motion. By this Order the Court summarily adjudicates that the Mid-Pac Creditors have made their prima facie case of a violation of Corporations, Partnerships & Associations Regulation 2.7 ("C.P.A. Reg. 2.7"). The liability of Semes and Gallen for that violation depends on the trial of their affirmative defenses to that cause of action. Of those affirmative defenses, the de facto corporation defense is insufficient as a matter of law. The Mid-Pac Creditors' cause of action for fraud, and the defendants' affirmative defenses to that claim also remain for trial.

A. Undisputed Material Facts

1. Herman P. Semes, Hatler Gallen, and Ambros T. Senda were the incorporators of Mid-Pac Construction Co., Inc.

2. Herman P. Semes, Hatler Gallen and Ambros T. Senda were the directors of Mid-Pac Construction Co., Inc.

3. Herman P. Semes and Ambros T. Senda executed a sworn Stock Affidavit for Mid-Pac Construction Co., Inc., on November 14, 1978.

4. The Stock Affidavit was filed on November 20, 1978 by the Office of Registrar of Corporations of the Trust Territory.

5. A corporate charter for Mid-Pac Construction Co., Inc. was issued by the Registrar of Corporations on November 20, 1978.

6. Mid-Pac Construction Co., Inc. engaged in business at the earliest by September 27, 1979.

B. Law and Analysis

1. First Cause of Action - Violation of CPA Reg. 2.7

The Mid-Pac Creditors' first cause of action asserts that Gallen and Semes are personally liable as incorporators of a corporation formed in violation of C.P.A. Reg. 2.7. In their motion, the Mid-Pac Creditors argue that Mid-Pac Construction Co., Inc. violated four provisions of C.P.A. Reg. 2.7, by engaging in business: (1) before three-fourths of its authorized capital stock had been subscribed; (2) before ten percent of its authorized capital stock had been paid in; (3) before $1,000.00 of its capital stock had been paid in; and (4) without filing an affidavit that complied with subpart 2.5 of the C.P.A. Regulations. Each failure is alleged to be a violation of part 2.7 of the regulations. Semes and Gallen are alleged to be personally liable as incorporators and directors.

No disputed issue of material fact exists on one of the four alleged violations, the failure to file a Stock Affidavit that complied with C.P.A. Reg. 2.5. That regulation requires that the corporation's officers file a Stock Affidavit setting forth required information, at the time of the filing of the articles of incorporation. Among the information required to be provided by the Stock Affidavit is the following:

e. The subscription price . . . for the shares . . . subscribed for by each subscriber, and, if it is to be paid in other than cash, the consideration in which it is to be paid;

f. The amount of capital and paid-in surplus, if any, paid in by each subscriber, separately stating the amount paid in cash and in property.

If it appears from the affidavit that more than fifty percent of the aggregate authorized capital stock of the corporation upon incorporation is to be issued for a consideration other than cash, or for the acquisition of the assets and business of any existing enterprise, the affidavit shall also contain a summary description of the consideration or the assets and business to be acquired as the case may be, and a net valuation thereof.

C.P.A. Reg. 2.5.

In opposition to the motion, Semes puts on evidence in an attempt to create issues of fact on the alleged violations of C.P.A. Reg. 2.7. Semes claims that before Mid-Pac Construction Co., Inc. engaged in business, three quarters of its authorized capital stock had been subscribed, ten percent of its authorized capital stock had been paid-in, and $1,000 of its capital stock had been paid in, because the incorporators paid-in cash and property to the equivalent of the cash value for each of the first three alleged violations. Semes further claims that the incorporators contributed equipment and materials belonging to the partnership, Mid-Pac Construction Company, to the required level to engage in business as a corporation.

Construing the facts favoring the parties against whom the motion is brought, it appears that the incorporators rolled over the assets and business of Mid-Pac Construction Company into Mid-Pac Construction Co., Inc. See Adams v. Etscheit, 6 FSM Intrm. 580, 582 (App. 1994). The incorporators did not state on the Stock Affidavit the following: that some consideration for the stock subscription was paid other than cash, the amount of capital and paid in surplus paid in property, and that authorized capital stock was issued for a consideration other than cash. The Stock Affidavit therefore did not comply with C.P.A. Reg. 2.5. Mid-Pac Construction Co., Inc. then engaged in business, and without filing an affidavit that did comply with C.P.A. 2.5, by indicating how much of the corporation's capitalization was paid in material and equipment. Engaging in business before filing a proper Stock Agreement is a violation of C.P.A. Reg 2.7: "No corporation for profit shall upon incorporation thereof engage in business in the [FSM] . . . until the affidavit . . . required by [C.P.A. Reg.] 2.5 [has] been filed . . . ."

Liability for violations of C.P.A. 2.7 is placed on the corporation's incorporators and directors.

In case of any violation of this section by any corporation, the incorporators and the directors thereof at the time the corporation commences to engage in business shall in their individual and private capacities be jointly and severally liable to the corporation and the stockholders and creditors thereof in the event of its bankruptcy or insolvency or in the event of its dissolution for any loss suffered by the corporation or its stockholders or creditors.

C.P.A. Reg. 2.7. Any incorporator or director is liable for violations. Mid-Pac Constr. Co. v. Senda, 4 FSM Intrm. 376, 384 (Pon. 1990), aff'd, 5 FSM Intrm. 277 (App. 1992).

The Court therefore summarily adjudicates the potential liability of Semes and Gallen to the Mid-Pac Creditors for the violation of C.P.A. Reg. 2.7, for failure to file an accurate Stock Affidavit, based on the foregoing undisputed facts and conclusions of law. Whether Semes and Gallen will be found liable depends upon their proof of their affirmative defenses.

2. Second Cause of Action - Fraud

Although the Mid-Pac Creditors moved for summary judgment, they made no explicit argument regarding their second cause of action, for fraud. The Mid-Pac Creditors allege: "The false stock affidavit of defendants SEMES and GALLEN was an act of FRAUD that proximately resulted in the formation of a wholly illegal corporation that creditors subsequent [sic] relied upon to their detriment." The elements of fraud are: (1) misrepresentations, (2) made to induce action by the plaintiffs, (3) with reliance by the plaintiffs upon the misrepresentations, (4) to their detriment. Pohnpei v. Kailis, 6 FSM Intrm. 460, 462 (Pon. 1994).

The Mid-Pac Creditors put forth very little evidence by which they might prove their case for fraud by undisputed material facts. It may be argued that the acts of Semes and Gallen in submitting property in lieu of cash constituted a fraud. But Gallen did not sign the Stock Affidavit, so it would be difficult on a motion for summary judgment to prove an actual misrepresentation on his part. The fraud claim against Semes is more colorable. However, his affidavit explains that although insufficient cash was paid in at the time of incorporation to meet the asserted level of capitalization, sufficient property in the form of equipment and materials was submitted. A question of fact remains as to whether the misrepresentation was done to induce action by the creditors. No evidence was presented that the creditors of Mid-Pac relied on misrepresentations to their detriment. These questions of material fact show that the claim for fraud cannot be summarily adjudicated by these motions.

3. Affirmative Defenses

Semes raised twenty-one affirmative defenses in his Amended Answer, while Gallen raised eighteen. Although some of the defenses were disposed if in earlier orders, several remain. When a plaintiff moves for interlocutory adjudication of all issues of a cause of action, including affirmative defenses, it must put forth evidence that no issue of material fact exists and that the defense is insufficient as a matter of law. Richmond Wholesale Meat Co. v. Kolonia Consumer Coop. Ass'n (I), 7 FSM Intrm. 387, 389 (Pon. 1996) (citing FSM Dev. Bank v. Rodriguez Corp., 2 FSM Intrm. 128, 130 (Pon. 1985)).

In their motion, the Mid-Pac Creditors address two of the remaining affirmative defenses, de facto corporation and estoppel to deny valid and lawful incorporation. The Court summarily adjudicates the affirmative defense of de facto corporation, Gallen's fifth and Semes's sixth affirmative defense. Semes submitted evidence that the High Commissioner issued a corporate charter on November 20, 1978. Gallen submitted no evidence that would create an issue of fact on this. In the prior case against their co-incorporator, Ambros Senda, former Chief Justice Edward C. King found that because Mid-Pac Construction Co., Inc. received its corporate charter and was indisputably a corporation, that the defense of de facto corporation had no relevance. Senda, 4 FSM Intrm. at 385. This Court agrees with Judge King's ruling and therefore holds that the defense of de facto corporation is insufficient as a matter of law.

The defense of estoppel to deny valid incorporation survives this motion because it appears to go to the claim of fraud. Although the Mid-Pac Creditors argue, based on Judge King's ruling, that the equitable defense of estoppel is not available to the defendants because they have unclean hands, the Mid-Pac Creditors have not submitted evidence that shows their own detrimental reliance. It seems plain that a plaintiff cannot disprove an affirmative defense to a cause on which it has given no evidence. At any rate, the claimed unclean hands - signing a false Stock Affidavit - would not apply to Gallen, who did not sign the Stock Affidavit.

Since the Mid-Pac Creditors did not address the other remaining affirmative defenses, those matters remain to be tried.

III. Motion to Sever

Ambros Senda moves to sever his trial against Herman Semes and Hatler Gallen. Senda claims the absence from Pohnpei of Daniel Berman, counsel for the Mid-Pac Creditors, has delayed prosecution of the case to his prejudice. The Mid-Pac Creditors oppose, asserting that any prejudice from delay is due more to the failure of Senda to prosecute his cause.

It is not clear whether Senda seeks severance of causes or separation of trials. He brings his motion pursuant to the last sentence of FSM Rule of Civil Procedure 21, on joinder: "Any claim against a party may be severed and proceeded with separately." But Senda requests a separate trial as relief, more appropriately rendered under FSM Rule of Civil Procedure 42(b): "The court, in furtherance of convenience or to avoid prejudice, or when separate trials will be conducive to expedition and economy, may order a separate trial of any claim . . . ." Rule 21 motions to sever are often more properly brought as motions for separate trials under Rule 42(b). 3A James W. Moore et al., Moore's Federal Practice  21.05[2] at 21-50 (1982). In short, causes may be severed and trials may be separated.

Because it is not clear under which rule Senda moves, the Court analyzes both. No reported FSM decisions interpret Rule 42(b) or the last sentence of Rule 21. It is therefore appropriate to look to U.S. authorities interpreting the U.S. Rule from which the FSM Rule derived. FSM v. Ponape Builders Constr. Inc., 2 FSM Intrm. 48, 52 (Pon. 1985). "[T]he discretion, and perhaps the power, to sever claims under Rule 21 and thus to convert them into independent actions . . . is limited to cases in which the claims are separable enough to make appropriate a separate final judgment with its usual consequences." 3A Moore et al., supra,  21.05[2] at 21-48. Separate trials should not be ordered unless such a disposition is clearly necessary. 5 James W. Moore et al., Moore's Federal Practice  42.03[1] at 42-37, 42-38 (1982).

In this instance, Senda's claims are not separable enough from those of the Mid-Pac Creditors to warrant severance, and a separate trial would not be convenient, avoid prejudice, or serve judicial economy. Senda has two claims for relief, variations on a claim of equitable contribution. First, he asserts that as an incorporator Semes is jointly and severally liable with him for the violation of C.P.A. Reg. 2.7, and that he is entitled to a contribution for the share of Semes's and Gallen's liability. Second, Senda claims that because he received no benefit from the corporation, unlike Gallen and Semes, that he should not be required to make any contribution on their behalf.

Adjudication of either of Senda's claims requires a finding that the other incorporators of Mid-Pac Construction Co., Inc. are jointly and severally liable for violating C.P.A. Reg. 2.7. The parties have acted under an apparent misapprehension of the scope of the decision in Mid-Pac Constr. Co. v. Senda, 4 FSM Intrm. at 376. The liability of Semes and Gallen is subject to proof. To prevail on his claim, Senda will have to prove a violation, as will the Mid-Pac Creditors. It does not serve economy or convenience to have two separate trials to prove liability. Likewise, the Mid-Pac Creditors' cause of action for fraud, both of Senda's claims, and many of the affirmative defenses remaining to Semes and Gallen, are all by their nature, equitable. All the equity claims and defenses should be tried and decided together to yield an equitable result.

IV. Motions for Attorney Fees

Counsel for the Mid-Pac Creditors submitted four separate motions for attorney fees. Semes and Gallen filed an opposition to the first three motions, but Semes does not oppose the fourth motion so long as none of the claimed attorney fees may be collected from him.

In the Order entered April 23, 1992, the Mid-Pac Creditors' claims against Semes and Gallen were assigned to the law firm of Rush Moore Craven Sutton Morry & Beh ("Rush Moore") on the same collection terms set forth in the Order of September 15, 1988. The 1988 Order is comprehensive. A Special Master was assigned to oversee the collection efforts by the Moon, O'Connor firm in the name of Mid-Pac. All sums collected were to be deposited with the Court. That firm was to be paid $25 per hour plus 25 percent of the gross amount collected, plus expenses. The firm was to bill the Court monthly, with a report of the previous month's activities. The Court barred disbursement until it was satisfied that the funds collected would be sufficient to pay.

The Court is aware that Rush Moore has prosecuted this case for several years without payment. As billable hours and expenses mount, Rush Moore has had no option but to file these repetitive and cumulative motions. Until now, there was no Order appointing a special master in this case with whom to report monthly. In all four motions, Rush Moore requests only hourly fees and expenses, and not the percentage of the gross amount collected. The reason is simple. Rush Moore has yet to collect any amount in this case. Unlike the companion case, Mid-Pac Construction Co. v. Senda, Civil Action No. 1988-099, no sum has been collected, from which attorney fees and expenses may be paid. The April 23, 1992 Order gives the Court discretion to deny payment until it is satisfied that sufficient funds exist to allow payment. Since there is no fund now, on this case, there can be no payment.

The four motions for attorney fees are denied without prejudice. The Court appoints National Justice Ombudsman Lucas Carlos as Special Master to create and maintain an account separate from the account maintained in Civil Action 1988-099 for all amounts collected and deposited in the name of the Mid-Pac Creditors. All pending and future requests for attorney fees and expenses shall be presented to the Special Master.

V. Conclusion

1. The Court summarily adjudicates that the Mid-Pac Creditors have made their prima facie case of a violation of Corporations, Partnerships & Associations Regulation 2.7. The liability of defendants Semes and Gallen for that violation depends on the trial of the remaining affirmative defenses to the cause of action for violation of Corporations, Partnerships & Associations Regulation 2.7. The de facto corporation defense is insufficient as a matter of law.

2. The Motion of Ambros Senda to Sever Trial is denied.

3. The motions for attorney fees filed by Daniel Berman is denied without prejudice. The Court appoints National Justice Ombudsman Lucas Carlos as Special Master to receive the sums collected in this case by the Rush Moore firm for the benefit of the creditors of Mid-Pac Construction Co., Inc. All pending motions for attorney fees and future reports and requests for payment shall be made to the Special Master, subject to approval by the Court.